Fixed interest rates are not a topic I have spent much time speaking about, quite frankly because they have been awful for the better part of the last decade. As we have seen more recent action by the Federal Reserve, making some simple changes can put some easy money back into your pocket.
The Fed Fund Rate is the most important interest rate in the world. It is the rate that banks charge each other to lend Federal Reserve funds overnight. The Federal Reserve uses the Fed Funds rate as a tool to help control U.S. economic growth and is a critical component to their monetary policy.
What does this mean for you?
Banks base their “prime rate”, or the rate they offer their best customers on the Fed Funds Rate, which ultimately influences almost every type of interest rate in existence. You have probably noticed that you did not earn much interest on your cash at the bank last year, or other short-term savings options such as savings accounts, or CDs. Even short duration bonds have been impacted by the low rates. This was primarily because before 2015, the Fed Fund Rate had been zero percent since December 16, 2008, when the Fed lowered it to combat the financial crisis of 2008. The highest was 20 percent in 1979 when Fed Chair Paul Volcker used it to combat stagflation.
As you can see in this chart, rates are still near a historical low. Even as the Fed Funds Rate (brown line) has increased over the last couple years, other interest rates of different term lengths haven’t necessarily followed. For example, while the Fed Funds Rate has increased, the 30-Year Treasury hasn’t moved much. This creates an economic phenomenon called an inverted yield curve, which you may have heard about in the news over the last few months as a possible signal of a future recession (which I will not discuss in this article).
So how can you profit in today’s interest rate environment?
Interest rates can impact you personally in different ways depending on if you are the lender or the borrow.
For example, if you are the borrower, meaning you are taking out a loan such as a mortgage, the low interest rate environment on a 30-year loan will actually be favorable to you. But if you are a retiree looking to enhance your fixed income, buying a 30-year bond to generate interest income to live off of will not be in your favor.
Let’s talk about where you can make some extra money!
Money Market Funds
Even in today’s interest rate environment, banks aren’t really paying any interest on your checking or savings account unless you tie up an excessive amount of cash. Checking account are necessary to keep your day-to-day and month-to-month living expenses in to provide liquidity to pay your bills, but you may want to consider shifting any excess cash into a money market fund.
A money market fund is a kind of mutual fund that invests only in highly liquid instruments such as cash, cash equivalent securities, and high credit rating debt-based securities with a short-term, maturity—less than 13 months. As a result, these funds offer high liquidity with a very low level of risk.
As with anything in life, there are tradeoffs. At Alison Wealth Management, we offer our client’s a private client cash management program which helps them put their hard-earned cash to work, while managing their liquidity needs. Our money market fund currently has a yield of 2.26%, which is a nice chunk of interest for your excess cash to earn. The tradeoff is these accounts may not be FDIC Insured and don’t provide the instant liquidity of a checking account. For example, if you invest some of your cash in a money market fund, you may need to execute a trade before that cash is available for withdrawal. Generally, this trade can happen same day, so it isn’t much of a downside, but it is why we still recommend our client’s keep at least 1-2 months’ worth of living expenses in their checking account.
CDs and Fixed Annuities
If you are willing to commit your savings into an account for at least 1 year, you can seek higher yields through CDs offered through a bank and annuities offered by an insurance company. CDs and fixed rate annuities are very similar with the exception of 2 elements:
- Fixed annuities allow you to pay tax on your interest each year or defer that interest while CDs mandate you pay tax each year by issuing you an automatic 1099. While interest from both are taxed as ordinary income tax rates, the fixed annuity may be more tax-efficient because of the deferral option.
- If you withdrawal funds from a fixed annuity before age 59.5, may be subject to a 10% IRS early withdrawal penalty. If you withdrawal funds from a CD before age 59.5, there is no IRS early withdrawal penalty. If you withdrawal your initial deposit from either a CD or an annuity before the maturity date (generally 1-5 years), you could face a penalty imposed by the bank or insurance company.
Here are two examples:
|3 Year Maturity
||5 Year Maturity|
|Current Fixed Annuity Rate: 3.10%||Current Fixed Annuity Rate: 4.10%|
|Current CD Rate: 3.05%||Current CD Rate: 3.25%|
Aforementioned are options available to enhance your interest in time horizons of zero – five years. For time horizon’s greater than five years, we would tend to lean towards other solutions via publicly traded equity and fixed income markets in addition to alternative asset classes to enhance your return.
By shifting some of your savings into higher interest-bearing solutions, you might be able to create more income or enhance your accumulation of wealth over time. We are big believers that every dollar counts, and if you want to learn more about how you can leverage the team at Alison Wealth Management to make your money work as hard as you do, request a quote at https://rate.AlisonWealth.com.
Rates are based on current interest rates and are subject to change at any time. Not all annuities are available in all states. Surrender charges may apply to withdrawals during the surrender period. A 10% IRS penalty may apply to withdrawals prior to age 59 ½. Annuity product guarantees rely on the financial strength and claims-paying ability of the issuing insurer. Annuities are not guaranteed by any bank or credit union and are not insured by the FDIC or any other federal government agency. Information presented on this website is not intended as tax or legal advice. You are encouraged to seek tax or legal advice from a qualified professional.